Hove's (CPH:HOVE) Earnings Are Of Questionable Quality

Despite announcing strong earnings, Hove A/S' (CPH:HOVE) stock was sluggish. We think that the market might be paying attention to some underlying factors are concerning.

Check out our latest analysis for Hove

Zooming In On Hove's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to June 2023, Hove recorded an accrual ratio of 0.36. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of kr.14.1m, a look at free cash flow indicates it actually burnt through kr.8.8m in the last year. We also note that Hove's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of kr.8.8m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hove.

Our Take On Hove's Profit Performance

As we discussed above, we think Hove's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Hove's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 79% EPS growth in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To that end, you should learn about the 3 warning signs we've spotted with Hove (including 2 which make us uncomfortable).

This note has only looked at a single factor that sheds light on the nature of Hove's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.